RISK ASSESSMENT

Moderate and stable growth in 2019

The Moldovan economy was rocked by a banking scandal at the end of 2014. More than USD 1 billion – equivalent to 15% of GDP – was misappropriated, the three major banks involved were bankrupted, and economic activity slowed significantly as a result. Growth is expected to remain at a moderate level in 2019, thanks to two 2016 events that enabled the economy to begin expanding again: the consolidation of the financial sector, and an increase in external demand (mainly from the EU and Turkey). Private consumption, which accounts for 85% of GDP and makes a significant contribution to growth, will continue to increase moderately. The low unemployment rate, combined with wage growth and the high level of remittances from Moldovan workers abroad (21% of GDP in 2017), particularly in Russia and Israel, will be offset by the negative impact of higher inflation on disposable income. Inflationary pressures linked to brisk domestic demand, in a relatively accommodative fiscal context, will no longer be mitigated as they were in in 2018 by the fall in administered prices (for gas and electricity) and the appreciation of the Moldovan lei. In addition, monetary policy is expected to remain tight. Moreover, even though agri-food exports continue to benefit from free trade with the EU, trade will still make a negative contribution to growth because of strong imports linked to domestic demand and insufficient diversification of production. Although low production costs are making the textile and clothing sector more attractive, with manufacturing struggling to build greater diversification, the distribution and agri-food sectors are the industries that will drive activity above all. Moldova also remains dependent on the primary sector, which accounted for 14% of GDP and 34% of employment in 2017, and weather conditions.

Persistent deficits and a fragile banking system

The Moldovan budget gets financial assistance from international bodies, including the IMF, whose ECF is injecting USD 178 million (2% of GDP) over 2017-2019, and the EU, which in 2017 introduced a macro-financial assistance programme of up to EUR 100 million. This support comes with fiscal consolidation requirements entailing a significant increase in revenues (including VAT) and diversification of revenue sources to meet social and infrastructure investment needs. Other conditions include cleaning up the financial system and improving governance (the EU has suspended its aid pending the elections). Despite reforms to improve the supervision of banks and their activities, the banking system remains tainted by irregularities. In October 2018, the EBRD and two private funds acquired 41% of the capital of the largest bank, MAIB, which had been state-owned since being confiscated in 2017 from shareholders who were colluding to launder money. By January 2018, the EBRD and Banca Transilvania had already acquired 27% of the capital of Victoria Bank, the third largest in the country. The state retains control over the second largest bank, Moldindconbank, which it took over following incidents of embezzlement. Under these circumstances, the authorities have chosen to limit the development of the system by imposing a 40% minimum reserve ratio on deposits in local currency.

The current account deficit is expected to remain high in 2019 due to the massive trade deficit (28% of GDP in 2017), despite remittances from expatriate workers. The main trading partners are the neighbouring countries (Ukraine, Romania), but exports to Western European countries – chiefly of agricultural products, electrical wires and clothing – are growing rapidly. To finance its current account deficit and maintain its foreign exchange reserves at the equivalent of six months of imports, the country uses concessional loans from the IMF, the World Bank, and the EU, with FDI remaining limited. External debt stood at 80% of GDP at end-June 2018, with public and FDI shares each accounting for a quarter.

Parliamentary elections in February 2019 will not ease the tension

The political scene is dominated by President Igor Dodon, elected in 2016 for a four-year term and a member of the pro-Russian Party of Socialists of the Republic of Moldova (PRSM), and the influential Vlad Plahotniuc, the country's richest man and head of the pro-European Democratic Party, which formed the government led by Prime Minister Pavel Filip. These two sides will face off in parliamentary elections on February 24, 2019. The outcome is uncertain, especially as the country has moved from a proportional voting system to a mixed one, in which MPs will be elected at local and national level. While the President is popular and the PRSM leads in the polls, their rivals have media support, the backing of Western countries and can tap into Moldovans’ fear of Russia. Nevertheless, both sides are satisfied with a scene where the opposition is mainly a façade, and the actors are playing on their respective relationships with either Russia or the West.

Moldova also has to contend with separatist tendencies in the eastern Transnistrian region. The area, which is Russian-speaking, enjoys autonomous status and self-declared its independence in 1992, calling itself the Moldovan Republic of Dniestr. Russian forces are stationed there.